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AARP EARNS "ABOUT $1 MIL." ANNUALLY IN ROYALTY FROM PHARMACY SERVICE CONTRACT, EXECUTIVE DIRECTOR BRICKFIELD TELLS HEARING ON NONPROFITS' UNRELATED BUSINESSES

Executive Summary

The American Association of Retired Persons earns "about $1 mil." in royalties each year from its mail-order pharmacy service contract, AARP Executive Director Cyril Brickfield testified at a June 29 hearing on nonprofits' unrelated business income tax before the House Ways & Means/Oversight Subcommittee. The association operates "on a flat royalty fee with our pharmacy service," which pays AARP 1% of sales, Brickfield testified. The total royalty "amounts to about $1 mil. per year." Rep. Flippo (D-Ala.) commented that the royalty agreement "sounds almost like profit." Brickfield pointed out that the AARP contract companies "all pay [Unrelated Business] Income Taxes, and as they go up in volume, while it is a percentage, we provide that the [royalty] fee is reduced." AARP provides "ceilings," so that "when it gets to be a certain amount of sales the percentage fee is reduced." Rep. Thomas (R-Calif.) asked how AARP became involved in services as diverse as pharmaceuticals, insurance, and travel. Brickfield explained: "Oftentimes suggestions are made" and are examined in terms of their potential usefulness. Need is further measured through focus groups and surveys. Once need for the service is determined, Brickfield continued, "we solicit organizations on a competitive bid basis [and] request that proposals be submitted to us. We set the standards" the companies must meet under contract. For example, "they may market only to our membership, using our name," he said. "Depending upon the services and what the practice is in the commercial industry, we enter into contract agreements" that run for five to seven years, Brickfield said. AARP first contracted for pharmacy service in 1959, he noted. Small Business Legislative Council President John Satagaj urged Congress to require nonprofit organizations to demonstrate that there is a need for a the service unmet by the private sector before venturing into a commercial field. There should be an "affirmative presumption that it is a commercial activity," Satagaj said, and the nonprofit group should demonstrate a need to provide the service "despite the fact that it is a commercial venture." Maintaining that health care is the second largest industry facing competition from nonprofit organizations, Satagaj contended that the recommendations made by the Treasury Department do not go far enough to correct unfair competition by nonprofit enterprises. Treasury has urged further study of the related business standard before seeking any changes ("The Pink Sheet" June 29, p. 5). "They are very positive in nature, and we're pleased that the department has recognized that there are problems in this area; however, I must say that we were disappointed . . . in that they did not go far enough with specific recommendations to take action in this area." Although he agreed with Treasury Department testimony that current law has "conceptual merit," Satagaj said "the problem is that the courts have rendered it meaningless." There is no recourse, "short of Congress getting involved and straightening out what was once good [legal] language." California Business Coalition Acting Chairperson Anne Gallagher Reed raised the issue of multi-tier pricing by pharmaceutical manufacturers. She said those practices give a cost advantage to nonprofit hospitals that sell prescription drugs to outpatients. Reed maintained that Dominican Hospital in Santa Cruz, California "is advertising to its inpatients and to any and all outpatients that filling a prescription can be done at the hospital pharmacy at a significant savings over the usual retail price." An example of the hospital's unfair competitive advantage, Reed said, is that "Dominican Hospital purchases nitroglycerin patches at a cost of 1› per patch, or 30› for a package of 30." In contrast, she continued, "a tax-paying pharmacy purchases this same patch at a cost of $1.15, or $34.50 for a package of 30. They purchase it from the same manufacturer." Because of the cost disparity, "the nonprofit hospital sells the patches to the public at $35 for 30 patches and realizes a profit of $34.70," whereas a retail pharmacy selling the same product at the same price "would make a profit of 50 taxable cents." In testimony prepared for the June 22 hearing, the Business Coalition for Fair Competition recommended four criteria for denying tax-exempt status to nonprofit organizations' outside businesses: "(1) Presence of substantial profits, (2) Method of pricing, (3) Competition with commercial enterprises, [and] (4) Commercial methods of operation." Coalition Chairman Joseph O'Neil maintained that any commercial activity, regardless of purpose, "should be potentially taxable." However, nonprofits should not be taxed "if circumstances make it impossible for for-profits to provide such services." The relatedness standard "should be abolished because it exacerbates competition by encouraging nonprofits to increase their receipts by taking advantage of the exemption for activities related to their purpose," O'Neil contended. The test for tax exemption should focus instead "on the nature and conduct of the activity, rather than on its purpose." The relatedness test "fails because it is difficult to categorize the activities of nonprofits," O'Neil contended. For example, a college bookstore's sale of computers "is directly related to a college's mission because computer instruction would be impossible if students could not afford to purchase equipment." Maintaining that current law presumes "nonprofits are acting in accordance with their exempt purpose even in their commercial activities," O'Neil urged: "The presumption should be reversed." The coalition would make the legal standard "a rebuttable presumption of non-tax-exemption." If the nonprofit "can demonstrate unique, compelling reasons for the tax-exemption, then we would allow for the continuation of the exemption," O'Neil said. "The nonprofit would have to prove its right to exemption, rather than requiring the public, through the [IRS], to build a case for why it should not receive an exemption."
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